What Happens When Inflation Rises?

When inflation rises, it becomes less affordable to purchase the same goods and services because the purchasing power of a currency decreases. This means that it becomes more expensive for consumers to spend money and, as a result, it negatively impacts the economy.

Why does inflation increase?

There are a few different reasons why inflation might increase but the main reasons include an increase in demand for a good or service, a change in fiscal policy or an increase in production costs.

Demand – when there is a strong consumer demand for a product or service, it can cause inflation because consumers are willing to pay more for the product.

Fiscal policy – if governments introduce expansionary fiscal policy, it can increase the amount of discretionary income for businesses and consumers. For example, if taxes are cut, businesses can spend more on employee compensation, new hiring or capital improvements. Consumers may have more money and, as a result, purchase more goods. All of this stimulates the economy as it causes more spending. More spending could result in an increased demand for goods and services which, in turn, leads to price increases.

Production costs – when production costs increase, for example wages and raw materials, it causes an increase to overall price and can cause inflation. The demand for goods remains the same but the supply of goods declines because production costs are higher. This means that consumers absorb the cost and products cost more.

What happens when inflation increases?

When inflation rises, it can affect the economy at many different levels. One of the main ways being that more people have to turn to short term unsecured loans, leading people to look for the likes of a $1000 loan and even larger loans like loans for $5000 or more.

Loss of purchasing power

At its most basic level, rising inflation will lead to a loss of purchasing power. This means that goods and services become less affordable and the same amount of money can buy you less than it previously did. The change in price will depend on the good and service as well as the exact amount that the inflation rate has increased by.

Low income families are more affected 

When inflation rises, disposable income for households  becomes less. This means that households have less money spare from their salary after they have paid their basic expenses. As a consequence, lower-income households are more affected. Because they had less money to begin with, their income now does not go as far and they may struggle to keep up with basic expenses, let alone any additional spending. 

Increased interest rates

When there is high inflation, there are also high interest rates. Central banks use increasing interest rates as a strategy of dampening the impact of high inflation. When interest rates are increased, there is less consumer confidence, less spending and lower economic growth.

Increased interest rates also means that it is more expensive to borrow money meaning that mortgages and loans can become more expensive and can deter consumers from borrowing money. 

Savings lose value

If you have a savings account, your savings will lose value during periods of high inflation. This is because purchasing power is eroded so the value of the savings will have decreased. Over a longer period of time, the real value of your savings will decrease and you may actually be operating at a loss. If you are living off your savings during period of high inflation, you may find that your money is not going as far and you may need to alter your current standard of living.